Stakeholder theory

Hidden LINK_POOL table:

External Links:

1. Darden School of Business (UVA - R. Edward Freeman): https://www.darden.virginia.edu/initiatives/business-roundtable/stakeholder-theory-modern-corporation
2. New York Times (Milton Friedman): https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html
3. Business Roundtable: https://www.businessroundtable.org/business-roundtable-redefines-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans
4. Harvard Law School Forum on Corporate Governance: https://corpgov.law.harvard.edu/2021/07/21/the-rise-of-stakeholder-governance-and-the-promise-of-purpose/

What Is Stakeholder Theory?

Stakeholder theory is a concept within corporate governance and business ethics that asserts that a company's success is dependent on its ability to create value for all key stakeholders, not solely its shareholders. This theory broadens the traditional view of corporate responsibility to include any group or individual who can affect or is affected by the achievement of an organization's objectives. These stakeholders typically include employees, customers, suppliers, communities, and the environment, in addition to investors. Under stakeholder theory, effective decision-making involves balancing the often-competing interests of these diverse groups to ensure long-term viability and positive societal impact.

History and Origin

The foundational work on stakeholder theory is widely attributed to R. Edward Freeman, who formally articulated the concept in his 1984 book, Strategic Management: A Stakeholder Approach. Freeman’s work challenged the prevailing notion that the sole purpose of a corporation was to maximize profits for shareholders. Instead, he argued that businesses must consider a broader range of groups essential to their existence and success. ⁴The idea gained traction as scholars and practitioners began to question the sustainability of a singular focus on investor wealth, especially as businesses became more interconnected with global society. Stakeholder theory emerged from an understanding that companies operate within a complex web of relationships, where ignoring any critical group could lead to financial or reputational harm.

Key Takeaways

• Stakeholder theory posits that businesses should manage for the benefit of all groups that have a "stake" in the company, not just shareholders.
• Key stakeholders include employees, customers, suppliers, communities, and shareholders.
• The theory emphasizes creating shared value and fostering cooperative relationships among these groups.
• Adopting stakeholder theory can contribute to a company's long-term sustainability and resilience.
• It often requires balancing competing interests and making complex ethical considerations.

Interpreting the Stakeholder Theory

Interpreting stakeholder theory involves recognizing that a company's overall health and ability to generate value creation stem from its relationships with a wide array of groups. Rather than viewing these groups as external forces to be managed, stakeholder theory encourages companies to see them as integral partners in achieving strategic objectives. This interpretation shifts the focus of strategic management from a narrow financial lens to a more holistic view that considers social and environmental impacts. For instance, strong employee relations might lead to higher productivity and innovation, while positive community engagement can enhance a company's brand and reduce operational friction. Understanding how each stakeholder group contributes to, and is affected by, the business allows for more informed and sustainable corporate practices.

Hypothetical Example

Consider "EcoBuild Inc.," a hypothetical construction company committed to stakeholder theory. Traditionally, a construction company might focus primarily on project completion and cost-efficiency to maximize returns for investors. However, EcoBuild Inc. adopts a stakeholder approach.

When bidding on a new residential development, EcoBuild considers not only the financial returns for its shareholders but also:

• Employees: Ensuring fair wages, safe working conditions, and opportunities for skill development. This commitment can lead to higher employee morale and reduced turnover, contributing to project efficiency.
• Customers: Designing energy-efficient homes using sustainable materials, exceeding minimum building codes. This builds customer loyalty and enhances the company's reputation for quality and environmental responsibility.
• Suppliers: Partnering with local suppliers who also adhere to ethical labor and environmental practices, even if their costs are slightly higher than distant, less scrupulous alternatives. This strengthens the local economy and ensures reliable, ethically sourced materials.
• Local Community: Engaging with local residents to understand their concerns about noise, traffic, and environmental impact during construction, and implementing measures to mitigate these issues. EcoBuild might also contribute to local infrastructure improvements or green spaces, building goodwill and minimizing potential opposition.

By prioritizing these diverse interests, EcoBuild Inc. aims to create a more resilient business that fosters long-term value and mitigates potential risk management issues that could arise from neglecting any one group. While initial profit margins might be slightly lower due to these considerations, the company anticipates greater stability, stronger relationships, and sustained success over time.

Practical Applications

Stakeholder theory has found increasing practical application in modern business, particularly with the rise of movements towards more responsible corporate behavior. One notable example is the growing emphasis on Environmental, Social, and Governance (ESG) factors in investing and corporate reporting. Companies are increasingly integrating ESG considerations into their operations, recognizing that addressing the concerns of various stakeholders, such as environmental impact and labor practices, can drive sustainability and financial performance.

For instance, the Business Roundtable, an association of CEOs of leading U.S. companies, redefined the purpose of a corporation in 2019 to state that companies should lead for the benefit of all stakeholders—customers, employees, suppliers, communities, and shareholders—moving beyond a sole focus on shareholders. This³ shift reflects a broader acknowledgment within the corporate world that a holistic approach to stakeholders is crucial for long-term success. Academic discussions also highlight the increasing relevance of stakeholder governance in promoting corporate health and value, particularly in the wake of global challenges that underscore the interconnectedness between stakeholder well-being and corporate well-being. This² framework underpins initiatives in corporate social responsibility (CSR), where companies actively commit to ethical and societal goals beyond profit.

Limitations and Criticisms

Despite its growing influence, stakeholder theory faces several limitations and criticisms. A primary challenge lies in the practical difficulty of balancing the often-conflicting interests of multiple stakeholder groups. Prioritizing one group's needs (e.g., higher employee wages) might come at the expense of another's (e.g., lower shareholder dividends or higher prices for customers). Critics argue that this balancing act can dilute corporate focus, making it difficult for management to make clear decisions or for performance to be adequately measured.

A significant critique comes from proponents of profit maximization and capitalism, most notably economist Milton Friedman. In his influential 1970 essay, Friedman argued that the sole "social responsibility of business is to increase its profits" and that corporate executives, acting as agents of the shareholders, should not divert corporate resources to social causes that do not directly contribute to shareholder value. He c¹ontended that such actions amount to taxation without representation, effectively spending other people's money (the shareholders') for a general social interest. This perspective emphasizes that social issues are best addressed through government policy and individual philanthropy, not corporate mandate. Some contemporary critiques also suggest that an overly broad interpretation of stakeholder interests could lead to managerial opportunism or a lack of accountability, as it becomes harder to determine who management is ultimately serving.

Stakeholder Theory vs. Shareholder Primacy

The core distinction between stakeholder theory and shareholder primacy lies in their answer to the fundamental question: For whom should a corporation be run?

• Shareholder Primacy asserts that a corporation's primary, if not sole, purpose is to maximize financial returns for its shareholders. Under this view, corporate managers have a fiduciary duty to act in the best financial interest of the owners (shareholders), with other considerations viewed largely through the lens of how they contribute to shareholder wealth.
• Stakeholder Theory, conversely, argues that a corporation should operate for the benefit of all its stakeholders—a broader group encompassing shareholders, employees, customers, suppliers, and the communities in which it operates. This theory posits that long-term corporate success is best achieved by balancing and integrating the interests of all these groups, recognizing their interconnectedness and mutual dependence. While shareholders are an important stakeholder group, they are not the only, or necessarily the supreme, consideration.

The confusion often arises because, in practice, a business cannot entirely neglect any critical group. However, shareholder primacy dictates that any benefits to non-shareholder stakeholders should ultimately serve the goal of maximizing shareholder returns, whereas stakeholder theory suggests that serving all stakeholders is an end in itself, which then leads to sustainable value for shareholders.

FAQs

What is the main idea behind stakeholder theory?

The main idea is that a company should manage its business in a way that creates value for all groups and individuals who can affect or are affected by its operations, not just its shareholders. These groups, or "stakeholders," include employees, customers, suppliers, local communities, and the environment.

Who are the different types of stakeholders in a business?

Stakeholders can generally be categorized into internal and external groups. Internal stakeholders include employees, managers, and owners/shareholders. External stakeholders can be customers, suppliers, creditors, communities, government agencies, and the natural environment.

How does stakeholder theory relate to ethical business practices?

Stakeholder theory is deeply connected to business ethics because it requires companies to consider the moral and social implications of their decisions on a wide range of parties. It encourages fair dealings, transparency, and a commitment to positive societal impact, often aligning with principles of ethical investing and socially responsible investing.

Is stakeholder theory legally required?

While specific legal requirements vary by jurisdiction, some countries and regions have corporate governance codes or laws that encourage or mandate consideration of broader stakeholder interests. For example, some jurisdictions allow or require directors to consider factors beyond shareholder value. Increasingly, market pressure and public opinion also drive companies toward adopting stakeholder-centric practices, even if not strictly legally compelled.

Can stakeholder theory lead to lower profits?

Not necessarily. While a strict adherence to stakeholder theory might involve allocating resources to areas that don't immediately maximize short-term financial gains (e.g., investing in employee well-being or sustainable supply chains), proponents argue that these investments can lead to greater long-term value, enhanced reputation, reduced risks, and stronger relationships, ultimately benefiting the company's financial performance and corporate governance over time.